In my earlier article‘Wallstreet Meltdown: Analysis of Impact on the Malaysian Stock Market’, I have derived model equations explaining the factors that determine the movements of the KLCI, the Industrial Index and the Finance Index. In the models I have derived, it was clear that the Indices are largely determined by five major factors, namely capital index, GDP growth, Consumer Price Index, Dow Jones Industrial Average and the RM/USD exchange rate.

Having done the above, it is now handy to compare the chart of the model KLCI against that of the actual KLCI. I have found this to be an important tool in making a forecast or as a guide in making investment decisions.

The diagram below shows a comparison of the two charts.

In the above diagram, the actual KLCI and Model KLCI levels are plotted respectively over a period from January 1997 to April 2009.

The deviation chart derived from the above, indicating the percentage deviations of the actual against the model KLCI is shown below:

The deviation chart shows that while the actual KLCI does not deviate much and often from the model KLCI, it did happen in a few cases, in particular in 1998, 2000 and so far this year. Where actual KLCI is higher than Model KLCI, this is a case of overvalued market and vice versa.

With KLCI at 965 points, the current market level is overvalued between 14.46% and 32.51%. The 14.46% figure is obtained by factoring into the equation a negative GDP growth of -2.2% as estimated by MIER for 2009 while the 32.51% figure assumes a steeper decline of the Malaysian GDP by -3.0% and decline in CPI by -0.7% as forecast by the Economist Intelligence Unit of London(EIU).

If KLCI is actually overvalued by 14.46% the market will likely continue to fluctuate moderately without increase in trend this year.

If, however, the EIU forecast is proven correct, the 32.51% overvaluation is confirmed, then the current market level cannot be sustained and the KLCI will likely plunge to a level between 500 and 600 points. Based on past observations, a serious overvaluation(exuberance) is often followed by equally serious undervaluation(panic).

In view of the severe recession the world is facing this year and an uncertain economic environment next year, Malaysia will definitely be affected. One cannot afford to ignore this unusually negative world economic scenario.

Whatever the actual outcome, it is too risky to put your money in the market now. I would rather wait on the sideline for the time being for a better time that may emerge soon. The risk of making a purchase now is that, emotionally,you may not be able to withstand a potential big plunge in the market.

Note

You may note from the second chart above, that as in the last ten years, it will help you make a calculated investment decision if you are a medium and long term investor. This is because it normally takes more than a year for the chart to move from top to bottom of the cycle and vice versa. A daily trader or short term investor may not find any clue from the above chart.

Even as a long term investor, after reading the chart, you still have to assess the prevailing economic and finance environment to guess whether the market is due to change its trend. Admittedly, this is the most difficult decision to make and will determine whether you will be a successful investor or otherwise.

DAH Ikhwan

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